Revision Notes

What is an Economic System?

Because of the fact that there is scarcity of resources and unlimited wants, it is always a problem to allocate resources in an efficient manner. We are constantly facing three basic questions. These are:

What to produce?

How to produce?

For whom do we produce?

Every community or country must choose and develop its own way of solving these problems. The way a country decides what to produce, how to produce and for whom to produce is called it Economic System.The three Economic Systems existing are:

Market Economic system

Planned Economic System

Mixed Economic System

Note:

There are no PURE command economies

There are no PURE market economies

Instead there is a continuum of different characteristics

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Market Economic System

The central thought of this system is that it should be the producers and consumers who decide how to utilise the resources. Thus, the market forces decide what to produce, how much to produce and for whom to produce.

Features

All resources are privately owned by people and firms.

Profit is the main motive of all businesses.

There is no government interference in the business activities.

Producers are free to produce what they want, how much they want and for whom they want to produce.

Consumers are free to choose.

Prices are decided by the Price mechanism i.e. the demand and supply of the good/service.

Advantages

Free market responds quickly to the people’s wants: Thus, firms will produce what people want because it is more profitable whereas anything which is not demanded will be taken out of production.

Wide Variety of goods and services: There will be wide variety of goods and services available in the market to suit everybody’s taste.

Efficient use of resources encouraged: Profit being the sole motive, will drive the firms to produce goods and services at lower cost and more efficiently. This will lead to firms using latest technology to produce at lower costs.

Disadvantages

Unemployment: Businesses in the market economy will only employ those factors of production which will be profitable and thus we may find a lot of unemployment as more machines and less labour will be used to cut cost.

Certain goods and services may not be provided: There may be certain goods which might not be provided for by the Market economy. Those which people might want to use but don’t want to pay may not be available because the firms may not find it profitable to produce. For example, Public goods, such as, street lighting.

Consumption of harmful goods may be encouraged: Free market economy might find it profitable to provide goods which are in demand and ignore the fact that they might be harmful for the society.

Ignore Social cost: In the desire to maximise profits businesses might not consider the social effects of their actions.

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Planned Economy

In a planned economy, the factors of production are owned and managed by the government. Thus the Government decides what to produce, how much to produce and for whom to produce.

Features:

All resources are owned and managed by the government.

There is no Consumer or producer sovereignty.

The market forces are not allowed to set the price of the goods and services.

Profit in not the main objective, instead the government aims to provide goods and services to everybody.

Government decides what to produce, how much to produce and for whom to produce.

Advantages

Prices are kept under control and thus everybody can afford to consume goods and services.

There is less inequality of wealth.

There is no duplication as the allocation of resources is centrally planned.

Low level of unemployment as the government aims to provide employment to everybody.

Elimination of waste resulting from competition between firms.

Disadvantages

Consumers cannot choose and only those goods and services are produced which are decided by the government.

Lack of profit motive may lead to firms being inefficient.

Lot of time and money is wasted in communicating instructions from the government to the firms.

Examples of Planned economies

North Korea

Cuba

Turkmenistan

Myanmar

Belarus

Laos

Libya

Iran

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Mixed Economy

A mixed economy is an economic system that incorporates aspects of more than one economic system. This usually means an economy that contains both privately-owned and state-owned enterprises or that combines elements of capitalism and socialism, or a mix of market economy and planned economy characteristics. This system overcomes the disadvantages of both the market and planned economic systems.

Features

Resources are owned both by the government as well as private individuals. i.e. co-existence of both public sector and private sector.

Market forces prevail but are closely monitored by the government.

Advantages

Producers and consumer have sovereignty to choose what to produce and what to consume but production and consumption of harmful goods and services may be stopped by the government.

Social cost of business activities may be reduced by carrying out cost-benefit analysis by the government.

As compared to Market economy, a mixed economy may have less income inequality due to the role played by the government.

Monopolies may be existing but under close supervision of the government.